In a recent article I looked at the idea of screening for cyclical value in sectors such as energy, mining and industrials. I concluded that some opportunities may be starting to emerge, but that they’re only likely to be of interest for investors with fairly long timeframes.

This week, I want to spend time building a screen to identify stocks that may have the potential to deliver more immediate gains – stocks with strong momentum.

Investing in momentum stocks means following the trend. But there’s more to it than this. There’s ample academic evidence to support the view that price trends and earnings upgrades can drive outperformance over 6-12 month periods.

This chart shows how stocks with stocks with high-decile MomentumRanks have outperformed the FTSE All Share index since 2013:

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Admittedly, it’s tempting to think that the current market is unlikely to provide many momentum opportunities. Rising interest rates may also dampen down investor enthusiasm for nosebleed valuations.

The FTSE 250 and SmallCap index are both down more than 15% this year, despite the recent rally. AIM has fared even worse:

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However, as Ed commented in October, “there’s rarely a bear market everywhere all the time”. The oil and gas sector has been one bright spot this year, but there are other winning sectors and companies, too.

A review of the main UK stock indices reveals that they all have a healthy number of risers, on a year-to-date view (as of 14/11/22):

Index

# YTD risers

% of index

FTSE 100

27

27%

FTSE 250

48

19%

FTSE SmallCap

32

14%

AIM All-Share

139

18%

There’s a clear trend here in the right-hand column, which shows the percentage of index constituents that have risen this year. Bigger firms have done better.

Of course, past performance is no guarantee of future success. Buying shares merely because they’ve already risen is unlikely to be a winning strategy. There are also reasons to be wary of momentum-driven investing during times of economic turbulence. Academic literature has shown us time and again that momentum stocks are outperformers during a downturn, but material underperformers when markets recover - a theme we explored more in this article.

What I want to do in this article is identify stocks with the momentum qualities that are statistically more likely to drive outperformance across a basket of stocks,…

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